A right of first refusal grants one party certain rights before these become available to anyone else. Overall, the intent is to make sure a person will not miss a commercial opportunity. This article sets out how a right of first refusal clause operates and how this clause may impact your business.
What is the Right of First Refusal?
A holder of a right of first refusal, which is found within an agreement or deed, has the option to accept a particular offer or opportunity before any other person. This contractual right arises in many contexts, including transactions involving the sale of business, consumer goods and real estate, which we have set out below.
What Types of Contracts Include a Right of First Refusal?
There are a variety of types of contracts which may include a right of first refusal clause, including:
| Shareholders Agreement or Constitutions | If a company is issuing new shares or where an existing shareholder is disposing of their shares, they may be required under the shareholders agreement or constitution to offer them to existing shareholders before offering them to third parties. This benefits the existing shareholders by ensuring that they have the chance to ensure against their shareholding being diluted and continue to maintain the same level of control of the company and decision-making. |
| Franchise Agreement | Leases may grant tenants the first right to purchase a property when the lease comes to an end or where otherwise, the landlord intends to sell the property. This gives the tenant the opportunity to expand their asset base at a premises that they have come to enjoy while saving the landlord agency and advertising fees in searching for a buyer. |
| Lease | Leases may grant tenants the first right to purchase a property when the lease comes to an end or where otherwise, the landlord intends to sell the property. This gives the tenant the opportunity to expand their asset base at a premises that they have come to enjoy, while saving the landlord agency and advertising fees in searching for a buyer. |
| General commercial contracts | If a company is issuing new shares or where an existing shareholder is disposing of their shares, they may be required under the shareholders agreement or constitution to offer them to existing shareholders before offering them to third parties. This benefits the existing shareholders by ensuring that they have the chance to ensure against their shareholding being diluted and continue to maintain the same level of control of the company and decision-making. |
What Are Key Terms in a Right of First Refusal?
The table below outlines the key terms in a right of first refusal clause.
| Timeframe and Notice | The clause should specify a timeframe in which a party can exercise their right of first refusal. Without a timeframe, the right may be open-ended and restrict the other party’s ability to deal with third parties. However, the specified time frame should not be overly short. For example, a franchisor should have sufficient opportunity to conduct due diligence before purchasing a franchise business. It will also specify how the exercise of the right may be made – which is normally in writing, to the notice addresses set out in the agreement. |
| Commercial Terms | The clause should indicate what the commercial terms are for the relevant offer or opportunity which will be taken up. For example, the franchisee and franchisor could decide on the sale price of the franchisee’s business upfront, the terms relating to how that price will be paid, and what standard form of sale agreement will be used in the transaction. Sometimes it will be difficult to fully flesh out all the commercial terms, as it often refers to a time in the future when circumstances may be different. In this case, the clause may need to require the parties to agree to negotiate in good faith the terms of any subsequent or new agreement relating to the opportunity or offer. |
| Selling to others | It is normally the case that if a party does not take up their right of first refusal, then it is a requirement of the other party not to offer the relevant opportunity (for example, the sale of an asset) on commercial terms that are no more advantages as that offered or negotiated with the first party. |
What is the Right of Last Refusal?
The right of last refusal operates differently. This right is typically activated in the interim period between a contract being negotiated and a contract being signed. If you have this right, this enables you to compete with a third party to retain your current business opportunity.
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Key Takeaways
A right of first refusal is commonly used in commercial contracts to the benefit of both parties. However, both parties should analyse the operation of the clause to determine whether it operates to their advantage. As such, before including a right of first refusal clause in your contract, you should consider a number of factors. You should consider whether you are granting or receiving the right of refusal. Additionally, you need to determine if the contract provides specific and sufficient time frames and defines commercial terms. Further, you should also determine if you require a valuation clause. Lastly, you should consider if you or the other party require additional rights, such as a right of last refusal.
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Frequently Asked Questions
A person holding a right of first refusal has the option to accept a business offer before anyone else. For example, shareholders leaving a company may be obligated to first offer their shares to the existing shareholders of the company in accordance with the company’s shareholders agreement. If this offer is not taken, the leaving shareholder may then offer the shares for sale on the market to third parties.
Yes, the right of first refusal can be waived if the parties benefiting from the right do so. An example would be where the existing shareholders of the company waive their pre-emptive rights on the issue of shares as a part of the share issue process.
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